Yves here. This post focuses on why bitcoin has gone from being a mere speculative mania to a potential risk to the economy. Futures contracts make is possible to engaged in levered speculation. The booms and busts that have had destructive real economy effects have involved borrowed funds, because the collapse blows back to lenders, who almost without exception have intertwined relationships with other lenders and/or the payments system.

Note that the exchanges have set pretty high margin requirements for bitcoin. From the CME’s website:

As of December 12, and subject to change, the Maintenance Margin for the BTC future is 43%, where the Initial Margin for Hedger is 100% of the maintenance margin and the initial Margin for Speculator is 110% of that number.. Margin offsets with other CME products will not be offered initially. Additionally, FCMs may require a margin level beyond CME Clearing’s minimum requirement.

However, some speculators are already working with borrowed funds, albeit not with the short fuses of margin accounts. Any leverage with an “investment” this volatile is playing with fire.

Stripped down to its basic elements, bitcoin is a classical fraud, a form of high-tech gaming that has captured the imagination of millions of greedy and gullible people around the globe. Participants exchange a legal tender dollar or some other real asset, for example, for a share of the limited supply of bitcoins at whatever the current price may be at the time. The participants exchange something for nothing – namely bitcoin, which have no intrinsic value or yield, but which trade over the world of ethernet, outside of the regulated world of banks and financial payments…the remarkable thing is that much of the effusive praise for bitcoin that is heard from participants is self-generated flimflam…

Sad to say, there is little likelihood of bitcoin displacing any of the existing fiat currencies sponsored by governments. First and foremost, the cost of solving the ever-lengthening blocks of cryptographic transactions is prohibitive. The total electricity consumed today by the bitcoin “miners” who validate the transactions (and thereby earn a 25 bitcoin reward) already exceeds the total power consumption of small nations.

The same technology that makes bitcoin secure as a means of exchange also makes it hideously inefficient compared to other payment technologies. But the more serious objection to bitcoin is that it enables criminals and terrorist organizations to move value around the world out of sight of national governments and law enforcement. Some nations that have already banned bitcoin include China, India, Sweden and Vietnam. So far none of the Anglo nations have been willing to prohibit this overt act of criminality – at least not yet.

“At the first serious (and likely coordinated) move by governments to regulate or bank the digital currency, bitcoin’s price will crash to zero,” writes Lawrence Baxter in The Wall Street Journal. “Panicked owners will rush to exit and the bubble will burst. Bitcoin futures and options may just as well be based on pixies and fairies. Nothing will be able to save them. Speculators will depart for the next lunacy, leaving behind the greater fools to wonder where their supposed wealth went and demand that government do something about it.”

The price of a rare tulip bulb on the futures market in Amsterdam in January 1637 was equal to ten times the annual wage for a skilled crafts worker. A single bulb was reportedly exchanged for 1,000 pounds of cheese at the height of tulip mania. The market collapsed precipitously starting in February 1637, bottoming out in May 1637.

According to Economist Brian Dowd, “By the height of the tulip and bulb craze in 1637, everyone.. rich and poor, aristocrats and plebes, even children had joined the party. Much of the trading was being done in bar rooms where alcohol was obviously involved…bulbs could change hands upwards of 10 times in one day. Prices skyrocketed… in 1637, increasing 1,100% in a month.”

Bit coin, the original crypto-currency, was valued at $.08 in July 2010; $8100 on November 20, 2017, and $17,900 on December 15, 2017. The sky is apparently the limit.

The danger of course,is not just that at some point, the bigger fools, the last purchasers of bit coin and the long term holders (“hodlers” in crypto-speak) will loose some or all of their money. That would be regrettable. But like straight forward pump and dump market manipulations of a stock some will win while others loose.

But, as in 2007 and 2008, the creative greed behind global financialization is creating not just a bubble in bitcoin and many other crypto-currencies as investors , as in Holland in 1637, pile into markets as buyers. There is a real and, I believe, rapidly emerging threat that bit coin and its ilk could follow dynamics similar to mortgage back securities as the basis for highly leveraged and complex financial instruments, like credit default swaps that were traded in unlimited volumes with no limits based on the actual number of mortgages.

Cyrpto-currency has now entered the leveraged futures market, creating the potential for to the momentous margin calls of the 1987 crash and the cross-market selling of 2007-2008. And there is no limit to the number of futures contracts. Derivative instruments of more complexity and undefined risks are almost certain to swiftly appear as they did in 2007 when,for example, insurance giant AIG took enormous bets to earn premium on credit default swaps on mortgage backed securities. After all were, these were AAA rated… The sudden collapse of mortgage backed securities led to a liquidity crisis. The securities could not be sold for almost any price and the giant financial institutions on wrong side of the bets were suddenly bankrupt.

As Frances Coppola in Forbes points out, “As more and more financial institutions with connections to the real economy pile into the cryptocurrency mania, the chances of a similar disastrous collapse rise ever higher, and along with it, the likelihood of Fed or even a government bailout.”

The intent of those driving the explosion of crypto-currency prices is not a desire use crypto-currency as a low cost, reliable medium of exchange verified by a transparent block-chain, but as a magic carpet to wealth. If you’d bought $100 worth of bit coins in 2010, they would be worth $1.79 million as of Dec. 15. 2017. It is paradoxical that crypto-currency, allegedly meant to free us from fiat currency, finds its liquidity and value in the all mighty dollar.

There is much to recommend block-chain for its potential use as a reliable and low-cost means of trade whether is is tied to crypto-currency or not. For example, bock chain is being used in Brooklyn, NY to test sale of solar energy from local producers to local buyers, with the exchange medium in dollars not crypto-currency.

The Media Lab at MIT is working on designing crypto-currency projects that could facilitate, for example, trades and transaction by the global poor purchasing and selling locally produced community renewable energy. Crypto-currency and block chain could be an important tool for people not just beyond power lines, but who live unbanked and with little access to cash or liquidity of any kind. Crypto-currency could become a reliable exchange medium and basis for a community controlled economy.

Bitcoin is also seeing the transaction costs for bitcoin transaction soar rising to $20 charged by block-chain “miners” whose computers verify transaction and at the same time create more blocks and produce more bit coins as part of the solution of the algorithm that verifies transactions. Far from being a means for vey quick cheap, anonymous financial transactions, bit coin is becoming slow and expensive to use. A newer generation of crypto-currencies like IOTA offers an improved block-chain with zero transaction costs and faster transaction all the better to attract investors.

Crypto-currencies could represent a tool for self-management and community economies, a way to use the internet to help challenge the growing netocracy of the Googles, Facebooks, Twitters, Amazons, Ali Babas and their ilk. But by making crypto-currency into an investment who use is part of a get rich quick scheme as opposed to a free instrument of exchange and trade it has become just another arrow in the quiver of making the rich richer and worsening the already grotesque distribution of income. Crypto-currency speculation will make some people rich, as does day trading and house flipping, where many more will loose then win.

I suppose the original sin of crypto-currency was to allow its purchase in dollars, and not, for example, in services provided by one to another based on labor time and materials. But the crypto-currency model is based on a limited quantity that makes it resistant to inflation, but enshrines scarcity and therefore value and the siren calls of greed and desire as it does for scarce commodities like cocaine or diamonds or gold.

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48 comments

While I think there is a place for crypto-currencies; maybe not for private citizens; the current mania is just that; based on ether. Governments are already trying to figure out how to control/regulate crypto.
With the exceptions of Venezuela and Russia’s (at this time) using crypto for oil and gas purchases, as well as international trade that can’t be sanctioned; I think Bitcoin is a scheme, as I’ve stated prior.
Russia’s crypto is gold backed and Venezuela’s is oil and gas backed.
Another thing, among many, is the number of crypto-currencies “out there”; at last count, somewhere around 1,000.
Unfortunately, the lure of quick fortunes, is to enticing for many to resist.

It’s ridiculous but has anyone/country/bank actually spent real dollars on this? I read some day ago that some country apparently had $6 billion or something worth of bitcoin.

I mean, cool for them but unless they use that to do anything, what is their real loss? I’m very not an economist (or good at math) but 0.08 cents to 17,000 dollars? Maybe that country just bout like, $1000 worth of bitcoins long ago. If so and if bitcoin crashes, then all they’d be out was $1000. And maybe until that happens they’re desperately trying to entice contractors to do amazing projects, promising millions in bitcoins. No takers though perhaps? Gee gosh.

Unless it goes on a lot longer than it should, it should end slightly well for some, and slightly bad for others.

I have yet to see any amount of actual established currency being at risk. Or even anyone who’d bought bitcoin at a low point and now has a $1,000,000 worth, or did last month, actually selling that.

Any actual verified examples of an early bitcoin investor (obviously an investment, not a currency) selling for huge money? Actual examples of any nation or bank investing actual significant monies in order to buy even just one bitcoin, at even just $10,000? Maybe some Balkan (no offense) bank might’ve took a chance and did buy a lot early, and now their bitcoin holdings are $17 trillion. Nice. How are they going to turn that into putting food on anyone’s table? Their managers? Their customers? Their country?

Housing bubble was actually with real physical houses. This current bitcoin thing is a filament of an idea, far as I can tell. Granted I have almost zero clue about economics, and/or investments.

I know one guy who bought one bitcoin in 2011/12 and still hasn’t sold, I don’t think he ever will. I know some others who bought in 2013/14 but had sold sometimes after for a wash. I’ve been asking around and so far only a few people around me are betting real money on this thing (the highest I’ve heard is around 10 grands). Given that I’m right in the population the most at risk (young adult males with some informatic skills), this is slightly reassuring.

Well sure, Bitcoin and all of crypto are in their infancy. If you know nothing about it and bought some only to leave it in some online wallet than you have no one to blame but yourself, that’s akin to cashing your paycheck and then leaving your wallet full of cash in the bank lobby for safe keeping.

Romania has about 4bln (or whatever it is now) in BC, as they broken up an organized crime syndicate and seized something north of 200k bitcoins, so it’s about 4bln give or take.

Romania’s national debt is about 16bln USD, so here’s a chance for a true MTM experiment (mind you, I’d not be surprised if a count of the bitcoin now revealed it was “only” 20k but with transfers captured in the blocks after the seizure.. )

Sometimes the use of an asset isn’t in selling it, but using it as collateral for a loan in legitimate money. I mostly fear the banks treating private electronic money as an asset. My collection of 1930s mil (10th of a cent) tokens is worth something, but not enough for a bank to make a loan on it.

Most BitCoin mining is now in China, and most recent investors are Chinese housewives. Not a good prospect at all.

Any actual verified examples of an early bitcoin investor (obviously an investment, not a currency) selling for huge money?

As a matter of fact just this morning the founder of Litecoin cashed out and sold his entire stake (or at least claimed he did – these things can be tough to verify).

Your larger points are valid in that if BTC went to zero a bunch of people would be out some paper wealth but the economic impact would be nil. I think there’s concern that financialization through futures markets and collateral loans would then transfer that risk into the global economy and financial markets but we are a long way from that. Futures trading is a few hundred contracts a day and about $100 million of notional value, and there’s not a soul around stupid enough to lend against BTC as collateral. There’s been a couple small company stocks that are “associated with investing in the Blockchain ecosystem” (a virtually meaningless statement) but those are much too small to be consequential.

Their real loss would be all the dollars they will never get back. Those first few who bought in at $0.08 per bitcoin will not lose all that much. But they will still lose every last 8 cents they spent on bitcoins.

But not everyone bought in at 8 cents apiece. Many people have been buying in at the ever-higher prices which they themselves keep driving ever-higher by paying still everer-higherer prices as the price of bitcoins keeps rising even more mucher everer higherer as ever fresh rounds of buyers keep chasing that which they keep pushing up.

And when it crashes back to zero, those who bought bitcoin with other peoples’ money will impose all those losses on the other people whose money they bought the bitcoins with. That goes exponentially for people or institutions which buy these bitcoins bets and derivatives with other peoples’ money.

If they are able to crash large parts of the economy around them as they crash themselves, those falling-domino crashes spreading out will mean more real losses for more real people.

And if the bitcoin losers are able to extort a bailout from society to pay them back for all the money they lost on bitcoin, that would be a third level of forced loss.

Perhaps the targeted future-bailouters should rally around a slogan starting now: No Bailout for Bitcoin.

” Welcome to Bitcoin. The self-wetting bed that thinks its a currency.”

I’m quit furious to see regulators and politicians at best doing nothing, at worst encouraging this bubble by calling Bitcoin an “investment”… Trading cryptocurrency, which is just a form of private gambling, shouldn’t be regulated, it should be banned, period.

The only upside is that it is so obviously a bubble that I hope serious players will never really consider playing along which would keep it from achieving “systemic risk” status. But, sadly, stupidity and greed could once again prevail.

Bitcoin is the crowning achievement of our Era of Fake Finance. The regulators (LOL!) and prosecutors should have stepped in loooong ago.

But that statement can also be made about LIBOR, CDS, and a litany of other “mainstream” “investments”.

It’s a barbell: Greenspan/Bernanke/Yellen/Kuroda/Draghi gargantuan mountains of faker and faker and faker free “money” on the one side, and neo-liberal TBTF, Obama “No Banker Left Behind” and a collapse of the rule of law on the other. All enabled by a supine populace that thinks deeper and deeper submission is the only option.

Let’s assume, for argument’s sake, that a nominal percentage of money invested globally makes its way into Bitcoin as a perceived store of value — and stays there (ie Bitcoin continues to work).

The price of one bitcoin would necessarily be thrust up to x (a figure much higher than it is now).

In those circumstances, would you look back and say Bitcoin was a bubble? Of course not. We know this because Bitcoin has been labelled a bubble at several of its previous all time highs — $33, $100, $1,200 etc. There were corrections, but no pops, and each time Bitcoin regathered and continued its march towards greater adoption and more value stored.

We don’t know where this is going, but absent complete technical failure (which can’t be fixed), I see no reason for it to be abandoned suddenly. The US could ban ownership (it won’t) and Bitcoin would still continue regardless.

I think one of the great ironies of Blockchain will be its greater benefit to socialist enterprise (e.g. community-based co-operatives) than capitalistic enterprise (e.g. cryptocurrencies & ‘prices’). Mainly because the ‘value’ of anything on the internet tends to zero over time (as will cryptocurrencies…).

When I first heard about the exchanges going to do futures, I thought they lost their minds. BC has nil fundamental value, and thus by definition can have any value whatsoever. It is trivial to imagine a situation where it goes from 50k one day to zero the next day – and unless the margin is 100%, daily, quite a few longs will lose a shirt.

I could care less about BC longs, but if there’s a sufficient number of them, this could have serious repercussions for the exchanges and the other participants.

I’m really curious what you think the difference is between bitcoin and Rai (Yapese stone money) or similar.

Sure, you can see and touch the latter, but they are otherwise useless and of no intrinsic value — and more often than not, they would rarely move.

If you could prove – mathematically – that you control a digital asset that is completely unique and can not be counterfeited, isn’t that worth _something_? It’s like you acquired a huge Yap stone. A digital asset with provable uniqueness and scarcity – something previously thought impossible – and with the added bonus of incredible utility (the ability to send it (or part of it) to anyone, anywhere, at any time, without requiring any third party support or consent). It is definitely worth _something_.

> It is trivial to imagine a situation where it goes from 50k one day to zero the next day.

The only situation I can think of is complete technical failure — something impossible to fix, such that the very idea of cryptocurrencies has to be abandoned completely (i.e. something beyond even the migration of bitcoin balances to a new cryptocurrency protocol).

My husband’s nephew works in the home equity loan dept. at a national bank in the northeast. He told us this weekend that, not long ago, a woman came in for a HELOC to buy $320k worth of Bitcoin. She managed to keep her intentions secret until the last minute when, in her excitement, she spilled the beans. No more loan but…wow.

Reminds me of the past craze of collecting baseball player cards. My grandchildren would pay $50.00 for a given card and declare: ‘I just bought a $200.00 card’. My reply: ‘Show me the $200.00!’ Bitcoin is more like crypto wampum.

The bitcoin bubble reminds me of the baseball trading card bubble. When prices went up,MANY companies started to print trading cards. While the supply of bitcoin may be mathematically limited, just about anybody can start their own crypto-currency. So the supply of crypto-currency is unlimited. People who object to the fact that only governments have a license to print money don’t realize that it is far MORE inflationary to give EVERYBODY a license to print crypto-currencies.

Sure, anyone can start a cryptocurrency — but can they make it secure, can they attract the brightest minds to work on it and can they develop its network effects? All very big asks. Bitcoin is light-years ahead (even if still finding its own feet).

The Australian Broadcasting Corporation (our government-run news service) has recently started quoting the latest price of Bitcoins in its hourly radio news updates, right after it gives the price of gold, oil and the value of the Aussie dollar against various currencies. A staid, respectable government information programme, now mentioning BTC in the same breath as real-world substances… How bizarre. Another sign that the mania is penetrating deeper into the public consciousness. I’d snark “Look at the bright shiny object!” but there IS no object here.

Why, in reading this article, do the words ‘pyramid scheme’ keep flashing in front of me? With the increasing energy costs associated with Bitcoin currencies, has anybody worked the maths to find out when it will take all the power generated in the world to equal the power this scheme uses some year down the track? Finally, when it finally does blow up, with Wall Street writing derivatives to all and sundry, will the US Government bail out all those financial institutions that get themselves into trouble over Bitcoin as being too-big-to-fail? Bailout Mark 2 anyone?

I’ve been a Bitcoin holder and enthusiast since 2011 – and for the first time 6 years I started to unwind a significant amount of my cryptocurrency portfolio. That is to say that even though I remain very enthusiastic about the technology on the very long term, I believe that the technology is far from ready for the general public and that the current prices are nothing short of insane… Anyway, I wanted to add my two cents on the following statement:

“Futures contracts make is possible to engaged in levered speculation.”

I agree with this statement in general, but note that leverage will be somehow limited as the margin requirements on Bitcoin futures are extremely high – 40% to 50%. My broker told me that they will not allow customers to trade Bitcoin futures for now, and even if they do they will most likely require that the contract be fully collateralized, removing the possibility of leveraging your position.

Exactly. Even with full collateralization, the benefit of CME futures is that the Chicago Mercantile Exchange is a well-capitalized counterparty with decades of history, regulated by the CFTC. Whereas with coin exchanges, you’re on your own to research how reliable they are. Regulation is sketchy or nonexistent.

I have pointed out before that the Merc would have failed in the 1987 crash except Continental Illinois resident Tom Theobald was in early and chose to violate the bank’s policies by covering for a $400 million CME customer “fail to pay”. That took place with only 3 minutes to spare before exchange opening. And Continental Illinois was then in FDIC receivership, meaning owned by the government. Would a privately owned bank have done that? Had the Merc failed, the NYSE would not have opened that day, and NYSE president John Phelan said it might never have opened again.

There is also plenty of academic literature now about central counterparties as a potential source of systemic risk. A lot of parties doubt that they are adequately capitalized against tail risk.

No risk-free counterparty exists. But CME Group is much bigger, solider, and more eligible for official support in a crisis (as your example of its systemic importance underlines) than any cryptocurrency exchange. Season’s greetings …

This is an important distinction: The blockchain technology is very interesting and quite promising in terms of the disintermediation of financial transactions. That is why many large banks are working on their own blockchain technology. As an example, blockchain makes possible near instantaneous settlement on payments between merchants or stock trading. Bitcoin (and other cryptocurrencies) is simply an expression of blockchain technology, an example of it’s utility, to some extent. It has no inherent value.

To draw from a past analog, the internet is blockchain; Bitcoin is Pets.com.

Two technical points
1) If the price of Bitcoins does ever drop, given the increasing amount of computation required to mine Bitcoins, at a certain price, wouldn’t mining become unprofitable? I assume that a lot of miners would continue for a while in hopes of a price recovery and the decision to stop would be driven by the marginal cost (mostly for electricity), which would be lower than the cost that includes the equipment, but still at a certain point, Bitcoin mining would be unprofitable.
2) Do I understand correctly that transactions in Bitcoin are carried out by these miners? If they stop mining, who carries out the transactions?
3) Oops, third point: Is it both true that China has banned Bitcoin transactions and that most of the miners and new investors are Chinese?

“If the price of Bitcoins does ever drop, given the increasing amount of computation required to mine Bitcoins, at a certain price, wouldn’t mining become unprofitable?”

Bitcoin auto adjusts its difficulty. The more power is deployed, the harder it gets. No matter how much or how little firepower is deployed on the Bitcoin network, only one block will be confirmed every 10 minutes and only 12.5BTC will be earned as an extra reward

It it that process that underlies the value of Bitcoin. The intrinsic value is the amount of computing power deployed to create the Bitcoins, and miners won’t tend to let them go for less than that which limits the liquidity forcing the price back up to clearance.

Once the mania dies down the transaction costs of Bitcoin will become prohibitive, driving more people off chain. That should cause computing power to be diverted to other cryptocurrencies and the transaction price to fall. But it depends how many off chain clearance houses spring up in competition to that process.

All in all it is an interesting experiment that gives us a lot of real world data about how a fundamentally worthless commodity is traded.

To clarify: That 12.5BTC is the current figure, but it will decrease to 0 over time, at which point miners will (in theory) be incentivized solely by transaction fees. I believe it started at 25 BTC.

Also, with regard to Jessica’s point #2 above: Yes, you understand correctly. The point of “mining” is to process transactions; the coins that are mined are mostly just there to make people want to do so. Therefore, no miners means no transactions, period.

1. Yes, if the price dropped to a dollar tomorrow, most miners would quit.
2. Yes, miners process transactions, adding them to the blockchain. If all miners were to stop mining, no transactions would be processed (save that new miners would quickly take their place, of course — even at one dollar, there is some profit to be made, not least because Bitcoin’s difficulty would adjust making it easier (cheaper) for miners to generate blocks).
3. China seems to have banned bitcoin exchanges, pending regulation. They are apparently looking at OTC trading too, but they have not banned the owning or holding of or transacting in bitcoin, as far as I know. It is fair to say that most of the miners are in China (miners chase cheap electricity and China has lots of it) but whether new investors are Chinese is impossible to say. It used to be that Chinese exchanges dominated daily volume, but that’s no longer the case.

The US population has essentially returned to pre-recession leverage – debt up the wazoo. China is not only at least as leveraged as the US, but it also has a housing bubble that dwarfs the US pre-recession bubble. Thus China is a case of double-bubble (my favorite gum as a kid). Then there is Bitcoin. If any of these 3 bubbles pops – it could a) cost some idiots a lot of wealth, b) create an immediate market correction, or c) trigger serial bubble bursts.

While markets might increase further, history suggests we are due for a big event by March. With the Great Recession in clear memory, it makes sense to go liquid for a bit. I might not see any gains for several months, but I sure as heck will not see any losses. Wonder why more people have not decided to sit out for awhile. Kool Aid anyone?

I just don’t care anymore. A coworker who isn’t particularly sophisticated financially and likes to gamble put a couple of grand in Bitcoin. I rolled my eyes. My responses were “You know, the price can drop just as fast.” and “Remember when Mt. Gox got hacked? I thought it was never coming back.” He’d never heard of Mt. Gox. I figured that was the canary in the coal mine, it was 100% a bubble. He’s a nice guy so I just said “don’t hold it, just be damn sure to get out when the price is high.” I doubt it matters.

Another former coworker mentioned it on social media. He also had done a sort of MLM scheme and threw a party to get friends to buy stuff. That says it all. It’s a a magnet for foolish get-rich-quick types, nothing more. I wouldn’t touch Bitcoin with a 10 foot pole.

If bitcoin does just what you say, and your coworker loses his thousand dollars, he will know you are a nice guy who means well. Hopefully he will like you for trying to warn him.

Also, he just might have respect for your predictive and analytical powers. If so, he might give you a respectful hearing on other sociocultural and political-economic things you might have to say about this and that.

And if he says ” where did you learn all that?”, you can bring him here, to this blog.

I repeated your own little experiment with a co-worker last night. He has been talking up bitcoin for some time now.

So last night I asked him whether the amount he had in there was small enough so that if it all went to zero it could be written off as an oh-well experiment. He said if it goes to zero he would be “screwed”. So I recommended to him this and some past articles about the unreliable nature of bitcoin.

So if he becomes a real world millionaire from bitcoin, he will have the last laugh. And if his bitcoin goes to zero, he will know that I cared and I tried.

The exciting thing in Roy Morrison’s article is the suggestion that Bitcoin be de-linked from any paper currency and valued on the costs of labor and materials of the goods / services traded. How would we do that?